3 Inverse Small-Cap ETFs Ready to Bear Gains

Investors piled into small-cap stocks in the first two months of the year as they tried to shield themselves from multinational companies caught in the crossfire of tit-for-tat tariffs imposed by both the United States and China in the then 10-month-old trade war.

However, since the start of March, small-cap stocks have failed to keep pace with their large-cap counterparts, with the Russell 2000 Index underperforming the S&P 500 by about 8.5%. Funnily enough, some market commentators attribute the dismal performance on the U.S.-China trade dispute. Steven DeSanctis, an analyst at Jefferies Financial Group, told CNBC the idea that small caps are more insulated from the trade war is a misconception. "It's a little bit of a fallacy because small-cap companies are suppliers to large-cap companies," said DeSanctis.

Moreover, double-digit percentage declines in small-cap earnings during the first and second quarter along with projected third quarter negative year-over-year growth of 6.1% should keep the lid on the group's recent bounce during the first two weeks of September.

Traders can play for a reversion to the mean using these three small-cap inverse exchange-traded funds (ETFs) that move in the opposite direction to the Russell 2000 Index. Below, we review the metrics of each fund and go over several strategies to exploit the Russell's range-bound price action over the past six months.

ProShares Short Russell2000 (RWM)

With assets under management (AUM) of $347.90 million, the ProShares Short Russell2000 (RWM) has a mission to deliver the inverse daily return of the Russell 2000 Index. Financials command the top index sector weighting at 17.63%, followed by health care at 15.85% and information technology at 15.39%. The 12-year-old fund turns over more than 500,000 shares per day on an average spread of just 0.02%, making it a suitable instrument for traders who what a short-term tactical bet against small-cap stocks. RWM's 0.95% expense ratio isn't exactly cheap but remains competitive for an ETF that provides inverse exposure. As of Sept. 23, 2019, the fund yields 1.34% and is trading down nearly 15% on the year.

RWM trended sharply lower throughout January and February but has since traded within a roughly four-point range. During September, the fund's price has retraced toward the range's lower trendline, which provides solid support at $39. Those who buy the pullback should consider setting a take-profit order near the pattern's top trendline at the $43 level. Implement risk management by cutting losses if the price fails to hold above this month's low at $38.94 and raising stop orders to the breakeven point on a rally above the 200-day simple moving average (SMA).

ProShares UltraShort Russell2000 (TWM)

The ProShares UltraShort Russell2000 (TWM) also tracks the Russell 2000 Index but aims to return two times the inverse daily performance of the benchmark. The geared fund provides an ideal instrument for traders who want a slightly more aggressive bet against smaller public companies – particularly those in the financial and health care sectors. Daily dollar volume of more than $16 million and a narrow average spread of 0.06% suits both scalping and swing trading strategies. Although the ETF charges an annual management fee of 0.95%, high holding costs likely won't be realized due to the fund's short-term tactical purpose. Traders should be aware that TWM rebalances daily, which may cause returns to deviate from the fund's advertised leverage due to the effect of compounding. Trading at $14.59, the ETF has net assets of $103.62 million, issues a 1.23% dividend yield, and is down 29.76% year to date (YTD) as of Sept. 23, 2019.

The 50-day SMA crossed below the 200-day SMA in early April, in what technical analysts refer to as a "death cross." Although the ominous signal usually forewarns further selling, the fund's price has remained entrenched in a trading range for the past six months. Last week, the ETF edged up from the range's lower support trendline at $14, which may trigger a move back to the June and August swing highs near $17 that form the sideways trend's upper resistance area. The trade offers an excellent risk/reward ratio of about 1:4, assuming a fill at Friday’s $14.59 closing price and a stop-loss order placed just below $14 ($2.41 profit per share vs. 60 cents risk per share).

ProShares UltraPro Short Russell2000 (SRTY)

Launched in 2010, the ProShares UltraPro Short Russell2000 (SRTY) seeks investment results that correspond to three times the inverse daily performance of the Russell 2000 Index. The fund, which holds assets of roughly $70 million, gives traders a cost-effective product for gaining short exposure to small-cap companies such as online marketplace Etsy, Inc. (ETSY) and specialty value retailer Five Below, Inc. (FIVE). SRTY trades about 700,000 shares most days, while its tight 0.05% average spread keeps slippage minimized. With an expense ratio of 0.95% and offering a 1.48% dividend yield, the ETF has tumbled 43.34% YTD as of Sept. 23, 2019.

SRTY's share price briefly slipped beneath an established six-month trading range last week but closed back above its lower support level at $22 on Friday, indicating a possible head-fake move to shake out weak hands. Traders may decide to wait for the moving average convergence divergence (MACD) line to cross above its signal line for added confirmation of an upside reversal before opening a long position. Those who do take entry should think about placing stops underneath the Sept. 13 low at $21.20 and booking profits near crucial overhead resistance at $28.